Debt ceiling negotiations remains the focus of capital markets, while the Fed continues to push back on rate cut expectations. Inflation continues to cool but remains elevated while recession fears remain. Finally, concerns remain over China’s growth prospects.
Debt ceiling negotiations continue to drive risk appetite while recession and inflation concerns persist. The Fed continues to push back on market rate cut expectations and questions on China’s growth outlook enters the fray this week.
The Fed meeting this week is front and center on investors mind’s this week, while recession concerns remain, and earnings season continues. JP Morgan bought First Republic from the FDIC and the Debt Limit fight continues.
Recession concerns remain ahead of this week’s 1Q GDP report, while earnings include bellwethers. Markets continue to price in Fed cuts later this year as the debt ceiling fight intensifies and inflation data continues to cool. 
A Fed pause and eventual cut remains the main question driving markets as earnings season enters the discussion. Inflation and growth concerns move down a few spots while debt limit concerns enter the fray.
OPEC has put the Fed over a proverbial barrel with their surprise output cut, which has put into question last week’s signs of cooling inflation and raised investor’s concerns about growth prospect. Oil has reentered the top five while last week’s number one, the stresses in US and EU banking sector, has fallen to the bottom as policy responses have calmed fears.
US and EU banking stresses and Fed rate path remine the main drivers of markets, while investors ponder growth prospects. Inflationary pressures show signs of easing while crypto stages a comeback.
Investors wary ahead of key inflation report as the Fed slows pace of hikes and hopes of a soft landing rise following a strong jobs report. A mixed 4Q earnings season wraps up and a surprise BOJ succession plan round out the top five this week.
Summary and Price Action Rundown
US equities were mixed and Treasuries remained under pressure as economic uncertainty deepens ahead of next week’s consequential US inflation, retail sales, and industrial production data. The S&P 500 recouped early losses to gain 0.2% today, upping its gain on the year to 6.5%, though the Nasdaq lost 0.6% to cut its early 2023 rally to 12.0%. Overseas, the Euro Stoxx Index underperformed, erasing yesterday’s outperformance, while Asian equities were mostly lower overnight. Longer-dated Treasury yields continued to climb, with the 10-year rising to 3.74%, while the policy-sensitive 2-year yield ascended to 4.52%. The growth-sensitive 2/10 Treasury yield became less inverted, but is still sending an alarming recession signal. The broad dollar hovered above seven-month lows, fluctuating well below its recent multi-decade peak of late September. Oil prices jumped as Russia cut production, with Brent crude climbing above $86 per barrel.
US Consumers Cheer Up but Sentiment Remains Subdued Overall
With investors pondering the crosscurrents and contradictions in US growth and inflation figures, a prominent survey showed some positive signals, but overall conditions remain challenging. The University of Michigan consumer sentiment for the US jumped to a thirteen-month high of 66.4 in February from 64.9 in January, beating market forecasts of 65, preliminary estimates showed. The gauge for current economic conditions improved to 72.6 from 68.4 in the previous month, but the expectations subindex fell to 62.3 from 62.7. After three consecutive months of increases, sentiment is now 6% above a year ago but still 14% below two years ago, prior to the current inflationary episode. Meanwhile, inflation expectations for the year ahead went up to 4.2% from 3.9% while the five-year outlook remained steady at 2.9%. Overall, high prices continue to weigh on consumers despite the recent moderation in inflation, and sentiment remains more than 22% below its historical average since 1978. Combined with concerns over rising unemployment on the horizon, consumers are poised to exercise greater caution with their spending in the months ahead. – MPP view: Growth data around the world has been mixed but we think the trend is to the downside, despite very noisy and idiosyncratic US labor market data. Our base case has been that risk assets will remain in a relatively placid period into Q1 this year as inflation peaks while growth is still positive, but the risk is that the recession arrives more quickly than we have anticipated. Global recession is our base case for 2023 with the lagged effects of the current tightening and US dollar spike really beginning to bite with a 6-12 month lag. We are more concerned about length of the recession and lack of stimulus and support for the recovery than we are about the severity of the retrenchment.
Rent Eases Ahead of Key Inflation Data Next Week
The median US rent increased by 2.4% annually to $1,942 in January, representing the smallest annual rise since May of 2021 and cheapest level in about a year. January’s number reflected the eighth consecutive decline in rent growth rate, and median rent also decreased by 1.9% from the previous month. Signs of increasing supply and reducing demand have possibly contributed to the fall in rent growth. On the demand side, broader economic pressure makes renters hesitant to sign leases. On the supply side, the increase in the number of real estate projects and homeowners deciding to rent out their properties has oversupplied the market. Additionally, the nationwide rental vacancy rate has reached near bottom in the fourth quarter of 2022 and is projected to increase in 2023. The cooling in rent prices is expected to help reduce inflation in the US. – MPP view: We think inflation continues to improve but the moderation tapers off through midyear and price pressures remains sticky, eventually driving home the point that the Fed keeps trying to make that it is not going to be in a position to cut rates later this year even if growth is weak and a recession is underway.
Additional Themes
Canadian Labor Markets Also Post an Upside Surprise in January – The Canadian economy created 150 thousand jobs in January, the most since February last year and much more than the market expectations of a 15 thousand increase. Gains were driven primarily by people aged 25 to 54, split evenly between women and men in this group. Additionally, the unemployment rate held steady at 5%, just shy of the record-low 4.9% observed in June and July 2022, and below market forecasts of 5.1%, signaling that the Canadian labor market remains stubbornly tight. The total number of unemployed people stood at 1.0 million, similar to the level observed since the summer of 2022. Meanwhile, employment increased by 150,000 and the size of the labor force has continued to grow, as an additional 153,000 people joined the labor force, boosting the participation rate to 65.7%.
Adidas Suffers from a Promotional Disaster – Adidas, the German sportswear giant, said late Thursday that it is assessing what to do with the Yeezy inventory, adding it has already accounted for the “significant adverse impact” of not selling the products. Operating profit would drop by about 500 million euros if the company fails to shift the products, and Adidas expects sales to decline at a high single-digit rate in 2023. The company also forecasted one-off costs of up to 200 million euros, leaving Adidas’ worst-case scenario for the year as a 700 million euro loss for 2023. Based on unaudited numbers, Adidas’ revenues increased by 1% in 2022, while operating profit dropped from almost 2 billion euros in 2021 to 669 million euros in 2022. Meanwhile, the company could lose around 1.2 billion euros ($1.3 billion) in revenue in 2023 if it is unable to sell its existing Yeezy stock. Shares sank 11% Friday morning as traders reacted to the announcements. “The numbers speak for themselves. We are currently not performing the way we should,” Adidas CEO Bjørn Gulden said in a press release.
Looking Ahead – Next week’s macro calendar centers around the highly-anticipated US Consumer Price Index figures for January, with the Producer Price Index also due. US retail sales and industrial production data for last month will be scrutinized for any signs of additional slowing. UK inflation and retail sales are also on the calendar, along with EU industrial production, Australian business and consumer confidence, and Japan GDP.
Latest Macrocast: America runs on trucking – On today’s Macrocast, hosts Meghan Pennington and John Fagan are joined by Loren Smith of Skyline Policy Risk Group to discuss the latest on the IRA and infrastructure spending, permitting reform and its impact on energy production, the debt ceiling, and more. Tune in here! https://marketspolicy.com/podcast-2/
Summary and Price Action Rundown
Global risk assets were mixed overnight as sentiment steadies ahead of tomorrow’s potentially pivotal US inflation figures. S&P 500 futures are pointing to a slightly higher open after the index recouped early losses on Friday to gain 0.2% and pare the week’s losses to 1.1%, taking its gain on the year to 6.5%, though the Nasdaq lost 0.6% for weekly downside of 2.4% to cut its early 2023 rally to 12.0%. EU equities are registering a moderate advance, while Asian stocks were mostly lower overnight. Longer-dated Treasuries are attempting to stabilize, with the 10-year yield holding at 3.73%, while the growth-sensitive Treasury yield curve remains deeply inverted, conveying a grim recession warning. The broad dollar is slightly stronger as it continues to fluctuate well below the two-decade highs of late September. Oil prices are reversing a portion of last week’s rebound, which was extended by Russia’s production cut, with Brent crude slipping back to $86 per barrel.
US Inflation in Focus
Traders are tentative ahead of tomorrow’s US Consumer Price Index (CPI) reading for January amid concerns of a disproportionate market reaction to an upside surprise. Treasuries are steady this morning but suffered meaningful selling last week as market participants fretted about the upcoming CPI data in light of the stunning blowout in January jobs figures. Investors are concerned that if CPI similarly tops estimates, the Fed will make good on its threats to raise rates higher than fed fund futures currently are pricing and hold them there for longer than market expectations reflect.
CPI is expected to reaccelerate to a 0.5% month-on-month (m/m) pace from 0.1% m/m in December, while Core CPI is forecast to remain steady at 0.4% m/m, equaling the prior month’s cadence. These readings would translate into annualized CPI and Core CPI readings of 6.2% and 5.5%, respectively, versus 6.5% and 5.7% in December. The Producer Price Index (PPI) for last month is due on Thursday of this week and is similarly expected to pick up on a monthly basis but cool further on an annualized basis.
Meanwhile, TIPS breakevens, the key market-based gauges of inflation expectations, moved higher last week but remain at generally subdued levels. Specifically, breakevens on 5- and 10-year TIPS are now trading at 2.51% and 2.34%, respectively, significantly lower than their cycle tops of 3.73% and 3.03% last March and April. – MPP view: Our anticipation is that easing inflation, hopes for a soft landing, and the conclusion of the Fed’s tightening cycle leads to an “eye of the hurricane” period of market calm though roughly Q1. We doubt that this tentative optimism will be the start of a new bull market, as we see improvement in inflation stalling and price pressures remaining sticky at above-target levels while the global economy continues to slow into broadly recessionary conditions by midyear, with scant prospect of either monetary or fiscal stimulus sufficient to jumpstart the engines of growth.
As we noted in Looking Ahead – More Than Words (https://conta.cc/3YCGuLI), recent major macro events, data, and earnings, posed a potential challenge to the continuation of our “eye of the hurricane” thesis for Q1, particularly as investors begin to reduce their bets on Fed easing later this year. But on balance, we think that the broadly positive market tone can continue until crystalizing recession risks later this year, alongside the Fed’s stubborn unwillingness to ease policy, bring stormy conditions back to risk assets.
Mixed Earnings Season Wraps Up This Week
Fourth quarter (Q4) earnings season has offered little direction to overall indexes and has done little to clarify the outlook. With 346 of the S&P 500 companies having reported, 55% have topped sales estimates and 70% have beaten earnings forecasts with divergent price reactions to the early results. Peak earnings season is now considered over, but this week still features some reports from industry bellwethers including Coca-Cola, Deere, Shake Shack, Shopify, and Zillow. Palantir is the most prominent company reporting today, with its results due after the closing bell.
Broadly speaking, Q4 earnings season as brought nothing too dire or distressing but few major positives to cheer about either, and has reassuringly indicated that corporate America is not seeing recessionary conditions on the horizon. Corporate management is broadly wary of consumer fortitude later this year, and banks are preparing for deterioration in their credit books, but this cautious outlook is far from universal, with some sectors and companies expecting some very upbeat quarters ahead. – MPP view: Nothing in the results so far is a smoking gun for a recession or a wholesale downgrade of broader earnings expectations (though we believe that is impending later this year), so macro factors have remained the main driver of stocks at the index level. So with Q4 earnings season providing little overarching direction and raising as many questions it answered, we maintain our baseline view that Q1 will feature a broadly reflationary and optimistic dynamic that will prove supportive of a risk asset rebound that probably goes on longer than it should given the gathering recessionary winds that will blow through the economy later this year.
Additional Themes
Geopolitics Remain Tense Amid Reports of Downed Objects Over North America – Following the matter of the Chinese spy balloon, headlines over the weekend indicated that more objects have been detected and shot down by the US Air Force. Fewer details have been provided about the latest series of objects that were downed. Meanwhile, this morning, Chinese official media has alleged that multiple US spy balloons have been detected over China in recent years, keeping the heat under simmering US-China tensions.
Looking Ahead – This week’s macro calendar centers around the highly-anticipated US Consumer Price Index figures for January, with the Producer Price Index also due. US retail sales and industrial production data for last month will be scrutinized for any signs of additional slowing. UK inflation and retail sales are also on the calendar, along with EU industrial production, Australian business and consumer confidence, and Japan GDP.
Latest Macrocast: America runs on trucking – On today’s Macrocast, hosts Meghan Pennington and John Fagan are joined by Loren Smith of Skyline Policy Risk Group to discuss the latest on the IRA and infrastructure spending, permitting reform and its impact on energy production, the debt ceiling, and more. Tune in here! https://marketspolicy.com/podcast-2/
MPP 2023 Outlook Video – In our first video of the new year, Brendan, John, and Bob discuss the MPP financial market and policy outlook for 2023, which calls for a return to stormy conditions after the more placid conditions of Q1 deteriorate as the Fed withholds rate cuts despite a deepening recession. Markets Policy YouTube Channel Watch Here
Russell Napier: 2023 – 2038 Forecast for Financial Repression / New Rules for Investors – We hosted a very revealing, compelling, and entertaining macro strategy session with macro legend Russell Napier on Friday, January 29, 2023. Russell is predicting an era of financial repression that reverses many of the characteristics of successful investing – we think this will be very worth your time. The full interview is on the Markets Policy YouTube Channel Watch Here